Arnold Schwarzenegger Saves China!

21 Sep

In this blog entry I am taking a break from my series on Building a Core China Portfolio – though there are more installments to come (See all 6 parts to date at this URL: https://ravendragon.wordpress.com/category/building-a-core-china-portfolio/).

I was asked by a friend yesterday why the industrial revolution sparked in the UK before most other nations. I’d assumed the catalyst was ‘philosophical/political’, i.e. the UK’s culture produced an environment conducive to mechanical development, such as property and individual rights. He suggested it was high wages. In other words, there was a specific macroeconomic driver behind the development of machinery to keep the pace of manufacturing, transport and infrastructure whilst replacing an element of the intense human capital involved. In turn I asked him why there had been no industrial revolution in the Roman Empire. He suggested there had indeed been a revolution of sorts, but I countered that it has not been truly mechanical.  My assumption was that there had been slaves – a source of cheap (or free!) labor. In other words my assertion about Rome was really the same reasoning behind my friend’s assertion about the UK. (Though note the wages argument is not totally divorced from my philosophical/political assumptions).

But what’s all this got to do with China? China has witnessed the most rapid industrialization known to humanity in the past 20 years, and all this came amidst the backdrop of very cheap labor.

With that dissonance in mind, my thoughts were drawn to two articles I’d read recently.  The first on a visit by California Governor Arnold Schwarzenegger to China, and the latter on the Chinese space program in today’s Guardian (http://www.guardian.co.uk/world/2010/sep/20/china-could-make-moon-landing-by-2025).

On a visit to China the Governor said he was “very, very” impressed by China’s bullet trains, and invited China to enter the bidding process for California’s own high speed train network. The Guardian carried comments by Ye Peijan, the head of China’s lunar exploration project. Peijan said that China could make its first manned moon landing in 15 years, and has the full capacity to accomplish Mars exploration by 2013. Even if much of this is hyperbole, the Chinese are only the 3rd nation to send their own people into space, and are certainly ploughing huge amounts of money into the R&D effort.

Now R&D is what I really want to focus on. There’s been much news recently about the increase in Chinese wages as the industrial worker supply/demand curve shifts in favor of the workers and away from employers (I’ve even written a little about the issues – https://ravendragon.wordpress.com/2010/05/31/the-redistribution-of-wealth-part-2/). The media has also been focused on the Chinese population pyramid. With the one child policy the pyramid is starting to invert, leading to the obvious question as to whether China can create enough wealth quickly enough per capita to pay for the needs of its aging population (a little like western Europe).

I would like to suggest the existence of a virtuous circle between the wages, need for growth per capita, and R&D spending / hi tech development in China. R&D spend will be precipitated in part by increased wages (much like the UK’s low-tech revolution). Increased R&D and productivity gains will help sustain high GDP growth, which will help pay for an aging population and fill the gap of a shrinking young labor force.

But can China do it?

On the positive side, over the past decade the number of tertiary education graduates has increased 5x (to 6 million in 2009). The country’s huge FX reserves and high savings rate provides deep pockets for not only education, but purchasing knowledge and technology. In addition, the country has a huge population over which to spread future R&D costs.

Nonetheless China still needs to revamp many institutions to pave the way for a major technological jump. In addition, the government needs to provide the right tax incentives and subsidies (recent history shows they can do this), and to open more competition and inclusion of the private sector (again, recent history shows this might not prove a stumbling block).

I would add another incentive: defense spending. Many countries have an embargo on military trade with China. This in and of itself might contribute to an internal technology breakthrough.

As investors, while much of the defense arena might be closed to us. But we should take note that other sectors such as telecoms, railways, and materials might start edging out foreign imports and foreign players, and potentially become global players over the next 5 to 10 years.

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